John Buell

On the Coming Challenges

Whatever the results of this election, the president may well face a three- headed monster. Though a tepid recovery is underway in the United States, unemployment remains high and some of the tools used to promote recovery carry significant risks of their own. Worse still, the specter of a Eurozone bankruptcy haunts the world economy. Finally a Eurozone collapse itself may trigger the worst political crises since the height of the Cold War. On both sides of the Atlantic, political leaders are beholden to investment bankers, who in turn are operating in a predatory fashion.

Here in the US any fiscal policy, even the modest jobs initiative proposed by President Obama in 2011, remains on hold. With fiscal policy paralyzed, all eyes are on the Federal Reserve. Its controversial Quantitative Easing 3 (QE3) includes two elements. First is the promise to keep interest rates low well into any recovery. Secondly, the Fed has committed to buy long term assets, including the infamous collateralized debt obligations, from its member banks. These steps have the endorsement of New York Times and Nobel Laureate Paul Krugman. Krugman has long—and quite properly— advocated expansionary fiscal policy. But absent that approach, he argues that a credible promise of inflation, which erodes the value of savings, will encourage savers to consume and invest.

Reasonable as this suggestion is, it disregards another possibility suggested by several left economists (see for instance comments on the blog Naked Capitalism) These economists include post Keynesians like Steve Keen, Philip Pilkington, Michael Hudson, and Modern Monetary theorists Randall Wray and Stephanie Kelton. They argue that investment decisions are not determined merely by interest rates and that unpredictable and volatile expectations play an enormous role in a crisis. Low interest rates and the fear of inflation may stimulate investment. But it may also encourage commodity or foreign currency speculation. More broadly, Krugman denies the role that investment banks play in creating money and thereby fostering booms and busts.

In this regard the signal Fed purchases of junk securities sends to the banks is especially dangerous. It constitutes one further message to banks that their speculative excesses will be backed up by the central bank. In a worst case scenario banks will take the extended low interest environment as an occasion to engage in new commodity speculation and securitization in the confidence that they can get out before any collapse and/or be bailed out in the wake of that collapse.

In Europe, the situation is even more dire. I recently had the pleasure of attending a conference on the Eurozone at Columbia University Law School. Greek economist Yanis Varoufakis was one of the featured speakers. He highlighted the damage that the continent- wide embrace of fiscal austerity is doing to citizens across the Eurozone and Great Britain. Spain and Greece are now experiencing conditions fully comparable to 1929. Even formerly prosperous and well- run businesses cannot find the short- term credit on which most business depends.

In Europe’s case a false diagnosis leads to a counterproductive cure. The US media routinely characterize Spain, Italy, Ireland, Greece and Portugal, the so- called PIGS, as just that, governments that have overspent their means. Such accusations are totally wrong in the case of Spain and Ireland, which were both models of fiscal rectitude before their banks blew up. Other than Greece, the remaining states had fiscal problems, but these were well manageable. Rather than a matter of public sector profligacy, the Eurozone crisis is anchored in its faulty architecture. Its nations share a common currency but no common fiscal (centralized tax and spending) mechanism.

Some brief background is useful here. From the early fifties the core European states had a common market but no common currency. The Lira, the Deutschmark, the Frank etc floated against each other, changing daily in relative value. In practice these floating arrangements provided some protection against “asymmetric shocks,” such as a sudden decline in world appetite for Italian wine. In such an event, nations could allow their currencies to devalue and thus become more competitive. Such devaluations were not without pain, especially inflation, and could lead to competitive devaluations by other nations. Nonetheless, devaluations did give damaged economies the prospect of return to prosperity.

In Europe, with the creation of a common currency zone, where a Euro in a Spanish bank was worth just as much as a Euro in German banks, it became easy and attractive for German bankers to invest in houses and commercial real estate in Greece, Ireland, and Spain. Banks made billions. Then a real estate bubble that would make Nevada look like the epitome of prudence burst. Banks became insolvent, lending and economic growth collapsed. Nonetheless, these nations had no way to devalue except to wait for a long slow process of unemployment leading to wage declines—even as the core European states strove to control their own“ labor costs,” thus depressing their demand for foreign goods.

Thus far Spain and Italy have not defaulted on their bonds, but each rescue package has involved one step forward and two back. Europe has enacted a pure fiscal orthodoxy more burdensome than even current US policy. Using a US analogy, Varoufakis imagined what would happen if following the housing bubble collapse, Nevada had been asked to recapitalize its own banks and had been unable to avail itself of unemployment compensation from Washington.

The levels of austerity imposed in Europe have not been seen in any advanced economy since the thirties. The self-inflicted crisis has been used as an occasion for a full- fledged attack on the welfare state. Struggling states are told they receive no assistance unless they meet the demands of the German- run ECB.

Austerity is promoted as a means of saving the people from its own excesses, but in fact is intended to save German banks from theirs. And it will fail. As economies shrink, tax receipts do also. Debt grows. Worse still, the demands on the peripheral European states are sold to the Germans on nationalistic grounds. The Greek and Spanish grasshoppers have lived lives of excess while industrious German ants labor away and sacrifice for a rainy day. Such fairy tales can only feed even more extreme forms of xenophobia. Varoufakis reminds us that the politics of hate and xenophobia thrive amidst pain. In Greece, the neo-fascist Golden Dawn is currently registering 22% in the polls, but even more ominous is the way mainstream parties are embracing some of its demands.

A fractured eurozone with banks and states defaulting on obligations to each other and surely to US banks, a second banking crisis here just waiting to happen, rising nationalism and authoritarian or even fascist governments in Europe. All this awaits the next administration. Whoever assumes power next year must be pushed to think outside these conventional boxes.